This type of M&A will be healthy in 2013, but with smaller deals

John C. Riddle is a managing director and principal with Cleveland investment bank, Brown Gibbons Lang & Co. Mr. Riddle heads the firm's Healthcare & Life Sciences practice and has more than 20 years of investment banking and capital markets experience.

At the same time, 2012 was a very productive year and a modest year in health care mergers and acquisitions: Approximately 1,065 transactions were completed (the most since 2007), totaling approximately $143 billion in transaction value (the lowest since 2003). M&A in the first quarter of 2013 experienced a significant decline, off 30% to 40% in both deal volume and value, compared with the like quarter last year and the fourth quarter. What's behind the numbers?We are not concerned about the first quarter results and expect 2013 will be a good year for health care M&A. The dip in volume in the first three months is likely a result of deal fatigue after a very busy fourth quarter in 2012, along with concerns over the impact of sequestration and the deficit. Private equity funds continue to have a huge surplus of investible capital, U.S. banks are well capitalized and eager to back transactions, and corporate buyers on balance have a large cash hoard and are looking for growth.This, along with other secular trends, will drive M&A in 2013.What's more interesting is a likely continuation of the 2012 M&A pattern — many transactions, but smaller strategic deals.Ongoing reform initiatives both in Washington and at the state level are a key driver of M&A. Life sciences companies are facing increasingly difficult and costly regulatory processes for new drug and device approvals, which is causing the larger companies effectively to outsource new product development to smaller entrepreneurial companies. Instead of internal research and development, these large life sciences companies are acquiring emerging companies that have born the early-stage risk and cost of product development.Hospital systems are being pushed by Obamacare to take on more risk through Accountable Care Organizations. To do so, these systems need to gain scale, acquiring smaller hospitals, physician practices and ancillary services. Providers that are reliant upon state Medicaid programs, such as nursing homes, are under pressure to increase occupancy and to reduce costs as state budgets reduce reimbursement. This forces consolidation among the smaller operators in these sectors.Health care product and services companies continue to seek avenues for growth and competitive advantage. Large pharmaceutical mergers have slowed down dramatically, as the industry's focus shifts from cost reduction and efficiency to growth. This favors smaller strategic acquisitions of innovative biotechnology companies over a mega-merger. The same trend continues with medical device companies wherein large consolidators are buying emerging middle market companies to expand into new markets, much like Mentor-based Steris Corp.'s acquisition of US Endoscopy last year. Hospital systems such as Cleveland Clinic and University Hospitals will continue their buying spree, snapping up providers and services that offer novel disease state treatments or patient connectivity.In short, regulation and innovation both are catalysts to M&A activity in health care for 2013 and beyond.

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